Earnings estimates at risk of further downgrades2 min read . Updated: 20 Nov 2015, 07:42 AM IST
Analysts see downside risks to earnings estimates owing to sluggish operating performance of firms in 2QFY16 and continued weak economic conditions
Earnings estimates were cut sharply for the fourth straight quarter, as results of Indian companies continued to be weaker than expectations. Kotak Institutional Equities has cut its FY16 estimate of Sensex earnings by 5.6% since end-September. It now expects Sensex earnings (adjusted for the index’s free-float weights) to grow by merely 6.5% in FY16 compared with around 18% at the beginning of the year.
Here’s the really worrying bit: Kotak’s analysts say in a note to clients, “The risks to our FY17 earnings have increased post the 2QFY16 results given the sluggish operating performance of companies in 2QFY16 and continued weak domestic and global macro-economic conditions. We see downside risks to our estimates for several sectors."
Kotak, like most other brokerage firms, has cut estimates for both FY16 and FY17. But it’s important to note here that earnings growth estimates for FY17 have actually increased. In Kotak’s case, its Sensex earnings estimates for the next fiscal year suggest growth of 20.5% compared with its estimate of the current year’s earnings. At the beginning of April this year, FY17 earnings were expected to grow by 18.7% compared with the then estimate of FY16 earnings.
As such, the risk to earnings it talks about should be taken seriously. The relationship between reported earnings and revisions to earnings estimates this year shows that brokerage firms tend to make meaningful corrections (in estimates) fairly late in the day.
It almost looks as if with each passing quarter, it becomes more evident that forward earnings estimates are aggressive and need to be toned down. Unless there is a dramatic recovery in several industries, expected growth of over 20% next year is clearly asking for too much. For instance, a number of sectors such as automobiles and consumer goods benefited from weak commodity prices, and reported a handsome growth in margins. But it looks like this advantage will be lost next year. Kotak also points out that there are downside risks to earnings of commodity sectors, as its assumptions include higher prices next year. A high amount of non-performing loans at banks could well mean increased provisions in the future and hence lower earnings.
As far as the September quarter results go, while there were some pockets of improvement, they were few and far between. Among the large and important sectors, banks continued to report slippages in their portfolio and non-performing loans remained high. Capital goods companies disappointed on order inflows. Sectors dependent on consumption demand reported drops in growth rates; a number of them growing volumes in low single-digit levels.
With the government thankfully moving ahead with some reform measures, investor sentiment may get bolstered to some extent. But if earnings continue to disappoint, and estimates continue to be revised downwards, valuations will look far richer than they already are. As Kotak’s analysts say, “Valuations may look pricey when (and not if) earnings get cut further."